How the Debt Avalanche Method Works
[ad_1] The post How the Debt Avalanche Method Works appeared first on Millennial Money. It’s time to face an uncomfortable truth: You have a significant amount of credit card debt and/or student loans, and it’s dragging you down. And the longer you remain in debt, the worse it’s going to be. If you’re in this position, becoming debt-free may seem impossible. But the truth of the matter is that you can do it. You just need a strategy that aligns with your income and budget. One such strategy to consider is the debt avalanche method, which may be the fastest and most direct way out of your financial rut. This post explores the debt avalanche method and how it works. What is the debt avalanche method? As the name suggests, the debt avalanche method (as opposed to the debt snowball method) involves throwing a large amount of capital all at once at a credit card balance to try to wipe out your debt or even just collect a small win and get an issuer off your back. If you have $5,000 sitting in the bank and $3,000 worth of debt, the avalanche method would involve making aggressive payments or paying it off in its entirety with a single payment, thereby avoiding unnecessary interest charges. Under this method, sort your debt from highest to lowest interest, or from highest to lowest balance, and work your way down the list. Once you pay off your first debt, move on to the next one, and keep going until you’re debt-free. Why use the debt avalanche method? The basic concept behind the debt avalanche method is that it’s the fastest and most affordable way to get out of debt even though it requires spending a lot of money upfront. Decrease your overall debt load There is a strong psychological component to being in debt. It can be depressing making heavy monthly payments over time but not getting anywhere, and many people don’t like this approach for obvious reasons. The avalanche debt repayment method is like busting out of jail. With a handful of payments or one shot, you could make a credit card or loan go away, sending you out of debt completely, or at least knocking a high-interest credit card off your list and making it easier to pay the rest down. Boost your credit score Another benefit to the avalanche method is that it can boost your credit score. It’s not a guarantee, but paying off a large sum of money might move the needle on your report, especially if you’re reducing credit card utilization significantly. If you’re in debt, you might want to consider the debt avalanche method before shopping for a car or house and applying for a personal loan. In addition to possibly boosting your score, you can free more credit and increase your chances of getting a better interest rate on a loan. Check your credit score now with a free credit monitoring service. Save money One of the best reasons to use the debt avalanche method is to cut down on high interest fees, saving you a significant amount of money over time. Paying down debt with the avalanche method is the most cost-effective way to reduce debt. When to use the debt avalanche method The debt avalanche method isn’t for every situation. Here are some signs that the debt avalanche strategy is right for you. You have high interest rates The debt avalanche method is best for credit cards carrying large balances, along with higher interest rate loans. If you have a high amount of debt on a card with a low introductory rate, or a loan with a reasonable rate, you should think twice about the debt avalanche method. You could be better off paying down the credit card each month and then making a large payment at the end since it doesn’t cost much in interest. As for the loan, you may actually get penalized for paying it off too early. Some loans come with hefty prepayment penalties, so do your due diligence to understand what you’re getting yourself into. Your other credit cards are under control Another potential downside to the debt avalanche method is that it can leave you with less money for other high-interest credit card payments. Only use the debt avalanche method if your other credit cards and loans are under control, meaning they aren’t carrying massive charges. If you spend all your savings paying off one credit card debt but still have several other high-interest loans (and no money left to pay them down), you’re in more trouble than when you started. You’re happy with your credit score Keep in mind that not all debt is bad. In fact, for people trying to build credit, debt can actually be beneficial. Lenders are going to want to see that you can consistently make payments over time before sending you money. If you’re trying to build credit with a car loan, you may want to stick to a slow and steady pace. If you’re happy with your credit score, the debt avalanche method could be just what the doctor ordered. How to use the debt avalanche method Run a debt inventory Target the highest interest rate Figure out how much you can spend Use savings to make a payment Continue paying your other debts 1. Run a debt inventory Take a look at all of your accounts and add up your total amount of debt. List all of your credit cards and loans and try to determine how much you’re paying on a monthly basis. This activity can be a shocking experience if you’re not actively tracking and monitoring your debt. If you have several credit cards, you may be in for a surprise. However, it’s a necessary exercise if you want to get a handle on your financial situation. This is a habit you should be practicing regularly. 2. Target the highest interest rate Next, figure out the loan
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